ECON 1000 Lecture Notes - Lecture 14: Exchange Rate, Classical Dichotomy, Aggregate Supply

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emeraldwolf159

24 Mar 2017

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Economy tends to grow over time due to factor accumulation and technological progress. But in some years growth is slow or even negative. These are recessions (mild) or depressions (severe) Use model of ad and as to answer these questions. Fluctuations are often referred to as the business cycle. Misleading as the term cycle suggests regular and predictable. Data shows time between recessions can vary a lot. Real gdp is the most commonly used variable to monitor short-run changes in the economy. While direction of change is often the same magnitude can differ. When gdp falls the rate of unemployment rises. Unemployment rate rose sharply in three or four recessions. As the economy recovers unemployment falls back towards the natural rate. Previous chapters dealt with what determines macro variables in the long run. All based on the classical dichotomy and monetary neutrality. Most economists believe that classical theory describes long-run but not the short-run.

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Ques. 1 Read the following comprehension and answer the given questions . (2 x 2= 4 marks)

People often ask economists for predictions about the future of the macroeconomy. Forecasts about the economyâs future, even from experts, are not unlike a baseball writerâs prediction of who will play in the next World Series. The prediction can seem well-reasoned and logical, but it is hardly foolproof. Certain statistical series tend to move in similar ways through all business cycles. Knowledge of these series and their tendencies can provide some insight into future business cycle movements. The Conference Board, a not-for-profit organization, publishes monthly updates of what is called the âindex of leading economic indicators.â The index is a weighted average of 10 statistical series that usually lead, or begin turning upward and downward, before the overall economy does. Because not all the components of the index turn before the business cycle hits a peak or a trough, movements in the index are more reliable than the movement in any one of its components. Among the most reliable of the leading indicators is an index of prices for 500 common stocks. Investors want to buy stock shares when their prices are relatively low and sell shares when prices are relatively high. During a recession, stock prices fall due to sluggish sales and profits. Interest rates are relatively low during the last months of recessions because of reduced demand for investment. In choosing between buying bonds and stocks, investors will favor stocks when: (a) stock prices have fallen to a point where there is a strong possibility of future capital gains, and (b) the opportunity cost of buying stocksâthe interest rate on bondsâis low. Therefore, prices of common stocks will usually begin to rise during the late stages of a business cycle, before a business expansion begins. As the economy moves near full employment during an expansion, the situation is reversed. Strong demand for consumer goods and investment will drive prices and interest rates upward. At some point, investors sell stocks to realize capital gains and buy bonds, rather than stocks, to take advantage of high interest rates. The downward movement in stock prices will usually begin before a recession begins.

a. Scientists make accurate predictions of the movement of asteroids and comets. Why canât economists make accurate predictions of business cycle movements?

b. Assume that the U.S. economy is in a recession. Mild weather results in lower demand for energy and a reduction in the price of oil. Investors interpret this as positive news for firms because their costs of production will be lowered. An increase in stock prices results. Will an economic expansion follow?

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ECON 1000 Lecture Notes - Lecture 14: Exchange Rate, Classical Dichotomy, Aggregate Supply

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